Goodbye to the Exurbs and McMansions

Gary Shilling, editor of Gary Shilling's Insight, says the impact of the housing bust will be far-reaching and profound.

Back in the housing bubble days, many lenders thought that making houses "affordable" through ever-looser lending practices was not only profitable but their patriotic duty.

This pursuit of "affordability" was only sustainable in an era of rapidly rising house prices. But then the housing bubble broke. New home building collapsed after housing starts peaked at a 2.3 million annual rate back in January 2006. And the bubble's burst revealed the immense overbuilding during the previous decade of boom.

Through 2007, only 225,000 of [an estimated] two million extra house inventory overhang was eliminated, so about 1.8 million remains to be liquidated. And that's bad news for prices, even at current depressed levels.

We foresee housing starts dropping to an 800,000 annual rate level in mid-2009 and then recovering only modestly. From the October 2005 peak through June 2008, real new-home prices have fallen 18%, so they need to decline 12% further to reach our forecast total drop.

[Meanwhile,] the leap in gasoline prices has thrown a monkey wrench into affordability measures. Most of the new houses built in recent decades have been on the fringes of metropolitan areas where land is cheap and available.

But driving costs are rekindling the nascent demand for urban living spawned by young people and baby boomers in recent years. A recent Coldwell Banker survey of urban residential real estate agents revealed that 70% believe their clients are increasingly interested in city living.

Another development is working against demand for existing large houses in outer suburbs-the apparent end of the McMansion era. Single professionals, young families and retired empty nesters are increasingly downsizing and buying smaller houses. This new trend is being reinforced by the high energy costs for heating and cooling of McMansions. The trend will also be augmented by falling house prices that will convince many, for the first time in the post-World War II era, that great investments and places to live are no longer one and the same.

So, high energy costs make much of the houses built in recent years, largely in distant suburbs, less desirable. Economics teaches us that almost everything has value if the price is low enough. In this case, higher energy costs will depress suburban McMansion prices above and beyond all the other forces discussed earlier to reach the market-clearing levels.

American houses will again become affordable, but much later. Meanwhile, prices will likely fall considerably, even from current depressed levels, under the weight of excess inventories and higher gasoline costs for commuters. And before potential buyers consider houses again attractive and affordable, prices need to stabilize to the point that prospective homeowners become convinced that their biggest lifetime purchases won't soon be worth much less.